Annuities vs. Bonds: Do the math

As Americans face growing longevity risk, some are turning to annuities for guaranteed lifetime income as insurance against outliving their assets.

But while annuities are popular, they are not without controversy. Brian Rezny of Rezny Wealth Management, based in Naperville, Ill., says annuities are "inferior and expensive“ investments.

Rezny, a fee-only financial planner, argues that as investments, the returns are less than spectacular for investors, who typically receive 3% or less on a 25-year investment with no inflation protection.

Less than 3%? Rezny breaks it down like this:

An annuity offers the investor income for life -- but that income never increases. So, given current levels of inflation, each year the investor effectively receives 3% less. That means over the course of 20 years the income stream from an annuity that starts off paying $5,000 a year shrivels to the equivalent of $2,000. And, of course, there’s a good chance that inflation will increase well beyond 3%.

The income that the client does receive is generated from the money they used to purchase the annuity, he says, and it generally takes around 15 years for an investor to get his or her money back. Life expectancy for most people is 85 or 86. If a client purchases the annuity at age 65, then he would be 80 years old before he actually begins seeing a return on his investment. Clients who live only to 81 or 82 would see almost no return at all.

Those returns are diminished by the fairly hefty expenses that most annuities charge -- ranging between 3.5% and 5% a year. So a retiree whose annuity is earning between 5% and 7% (a fairly typical range, according to Rezny) is only receiving between 1.5% and 3% a year after expenses. Although they’re structured and sold a bit differently, both the expenses and the returns are similar for variable and hybrids.

“Annuities are sold because of the commissions they generate for the brokers,” Rezny argues. “They lock people into unrealistic expectations.”

Most of his clients, he says, would be better off simply buying U.S. Treasuries, which are far more secure and for which they would get a similar return without locking up their money for 20 years or having to pay surrender penalties.